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How Congress Crushed the BioTech ETFs

by ETF Base on May 4, 2014

Just like hot stocks, retail investors and institutional investors alike often chase hot ETFs as a momentum play figuring the good fortune will continue. Over the years, we’ve seen certain ETFs based on an asset class or investment theme outperform the market at large only to crash back to earth. During the commodities boom, we saw gold, silver and other commodities-related ETFs crushing the market. We saw volatility ETFs dominate during market crashes. We saw solar ETFs skyrocket when that was a theme. And at the end of the day, they’ve all come back in line (or worse) as those bubbles deflated. A recent theme we saw was the emergence of very strong performance from Biotech ETFs.

Biotech Theme

There were some key themes driving the biotech stock boom in recent years. First off, the notion that large pharmas didn’t have much pipeline strength anymore and were buying up small biotechs to keep up with competitors held true and still does today. Just about weekly, we see a major in-licensing deal or takeover announced, often with a premium of 40% or more over current share prices. This type of action had been driving very strong performance from biotech ETFs. For instance, the IBB ETF almost doubled the return of the Nasdaq in 2013 with a gain of 64% vs 37% for QQQ.

A Single Question Crushed an Index

There was a lot of press recently on Gilead’s HepC drug. As Gilead launched Sovaldi, patients and doctors alike were very keen to get access to the drug at any price. It raised eyebrows in the US where a single round of therapy is $84,000 or about $1,000 per pill. While this sounds like an outrageous price for society to pay for medication, the reality is that it is much cheaper (in both terms of treatment success, costs and side effects) than the alternative. Imagine if you had an incurable disease that could now be cured over the span of several weeks. So, for now, payers have been paying it. But the based on congressional questioning the seemingly outrageous costs earlier this year, it caused Gilead’s stock to tank. That in turn called into question the prospects for many other biotechs, causing the index to plunge. While biotech ETFs outperformed in 2013 and early 2014, they have underperformed since. IBB for instance is down 3% vs QQQ up 4% during the prior 3 month period. Talk about a reversal!

The takeaway here is that there are gains to be had with certain investment themes if you get in early. But you need to be prepared to pay a steep price for being on the wrong side of public opinion or a change in sentiment. Personally, I think longer term, biotech prospects remain strong, but there is still more room for downside given oncology and other indications which may draw similar scrutiny. For more on biotech plays, visit the BioTech ETF category articles.